Transcript Overview Of Course - University of Texas at Dallas

Lesson 3
1. The Meaning of Price, Value, and Economic
Efficiency.
2. Consumer and Producer Surplus.
3. Diamond Water Paradox.
4. Efficiency of Competitive Market equilibrium
5. Efficiency Implications of Price Controls and
Taxes.
1
Area under demand = total value of that
output
1
P1
2
3
Pe
5
4
D
Q1
Total Value of Q1 Units= 1+2+4
2
Qe
Total Value of Qe Units= 1+2+3+4+5
Area under supply = total cost (net of fixed costs)
P1
Pe
1
2
Q1
Qe
Increase in Total Cost when output increases from Q1 to Qe =1+2
3
Role of Price
1.
2.
Mechanism for Allocating Goods in
Markets: willingness to pay.
What are alternative mechanisms?
a.
b.
c.
d.
First come, first served
Strongest and most Powerful
Random Selection
Friends and relatives
4
Meaning of Price
1.
2.
What is the meaning of price when it is
used to allocate goods? What does a high,
or a low, price tell us about the product?
Diamond-Water paradox: why are
diamonds expensive when water is so
cheap?
5
Meaning of Price (diamond-water Paradox
Average Value Water
PA
Dwater
Swater
Pw
Total Value of Water is entire area
Qw
Average value of water is mid value of water used. So what does price measure?
6
Meaning of Price (continued)
Sdiamonds
Average Value Diamonds
Pd
Ddiamonds
QDiamonds
value of diamonds
7
Meaning of Price (continued)
Sdiamonds
Average Value Water
Average Value Diamonds
Pd
Dwater
Swater
Pw
Ddiamonds
QDiamonds
Total Value of Water
is greater than value of diamonds
Qw
Average value of water is also greater. So what does price measure?
8
Meaning of Price in Markets
1.
2.
3.
4.
Price Measures the value of the last unit
sold, or marginal unit.
Price, therefore, is unrelated to average or
total value of a product.
Salary, which is the price of labor, need
not be related to the “value” of the worker
or the work.
How can one group of workers generate
higher wages for themselves?
9
Consumer and Producer Surplus
1.
2.
Consumer surplus is the difference
between the price paid and the higher
price that consumers would have been
willing to pay for the product.
Producer surplus is the difference between
the payment received and the minimum
payment that producers would have
accepted.
10
Consumer and Producer Surplus
P1
1
3
Pe
4
2
Q1
CS = 1
PS = 2
11
Qe
DWL = 3+4
Price Controls
1.
2.
3.
4.
5.
Artificial Government Restraint of Price
Can be a floor, or a ceiling
Popular during wars, or in non-market
economies
Simple view: distortion in output
More complete view: wrong consumers
get product.
12
Price Floor at P1
1
P1
7
2
3
Pe
8
5
4
6
Q1
CS Before Price Control= 1+2+3
Ps Before Price13Control = 4+5+6
Qe
CS After Price Control = 1
PS After Price Control = 2+4+6
Price Floor at P1 AND wrong producers
1
P1
2
Pe
4
7
8
3
5
6
Q1
Q0
CS Before Price Control= 1+2+3+8
Ps Before Price14Control = 4+5+6
Qe
Q2
CS After Price Control = 1
PS After Price Control = 2
Rent Control (Price Ceiling)
1
2
3
Pe
4
7
Prc
5
transfer
6
Q1
CS Before Price Control= 1+2+3
Ps Before 15
Price Control = 4+5+6
Qe
CS After Price Control = 1+2+4
PS After Price Control = 6
Government guarantees price at P1 and and sells output at
market clearing price
S
1
P1
2
3
Pe
8
5
4
10
6
Pclearing
9
7
D
Revenue from Consumers
Q1
Qe
Q2
CS After Price Control = 1+2+3+4+5+6+10
CS Before Price Control= 1+2+3 PS After Price Control = 2+3+4+5+7+9
Ps Before Price Control = 4+5+9 Taxpayers = 2+3+4+5+6+7+8+10
16
Government guarantees price at P1 and burns any output it
can not sell at that price
1
P1
2
Pe
4
Pclearing
7
3
5
9
Q1
CS Before Price Control= 1+2+3
Ps Before Price Control = 4+5+9
17
8
6
11
10
12
Qe
Q2
CS After Price Control = 1
PS After Price Control = 2+3+4+5+7+9
Taxpayers = 3+5+6+7+8+10+11+12
Who Pays For A Tax?
1.
2.
3.
Terminology in Book is not exactly
correct.
Two forms of analysis: decreasing supply
or decreasing demand.
Tax burden is shared depending on slope
of both curves.
18
Price Paid by Consumer
Tax from consumer’s vantage
St
S
}amount of tax
P1
Pe
D
Q1
19
Qe
Price received by Producer
Tax from producer’s vantage
S
P1
Pe
P0
}amount of tax
D
Q1
20
Qe
Dt
Price Paid by Consumer
Distortion from Tax
St
S
}amount of tax
P1
Pe
P0
D
Q1
21
Qe
Instance of Tax borne by Producer
S1
P
Price Paid by Consumer
S
P1
D with infinite elasticity
Q1
22
Q2
Q
Instance of Tax borne by Consumer
P
D with zero elasticity
S1
Price Paid by Consumer
S
P1
P0
Q0
23
Q
Instance of Tax borne by Consumer
Price Received by Producer
P
S with infinite elasticity
P0
Dt
Q1
24
Q0
D
Q
Instances of Tax borne by producer
Price Received by Producer
P
S with zero elasticity
P0
P
1
Dt
Q0
25
D
Q